How Safe is SAFE’s Management of China’s Official Foreign Exchange Reserves?

This paper examines whether the State Administration of Foreign Exchange (SAFE) and its subsidiary SAFE Investment Company (SIC), the sole managers of China’s gargantuan official foreign exchange reserves (OFER) until 2007, have shifted their investment behaviour since the inception of China Investment Corporation (CIC). We find that external conditions such as overexposure to US dollar-denominated assets and declining value of the greenback, as well as internal conditions like the rise of CIC as a rival to manage China’s OFER, have prompted SAFE-SIC to depart somewhat from their pre-2007 conservative style of investing most of China’s OFER in low-yielding foreign government bonds, especially US Treasury bills. Since 2008, SAFE-SIC, in a seeming competition with CIC, have started to pursue higher-risk, higher-return investments. However, we observe that this bolder strategy of SAFE-SIC might not be sustainable for long, because: (a) it duplicates CIC’s explicit mission already set by the State Council to invest in higher-risk, higher-return assets; (b) it runs against SAFE’s core mission to preserve, rather than grow, China’s OFER; and (c) SAFE is tied down by other core responsibilities such as the regulation of China’s foreign exchange administration system, the stewardship towards full capital-account convertibility, and the gradual internationalisation of the renminbi (RMB). As such, engaging in higher-risk, higher-return investments would most likely remain a secondary priority within SAFE’s overall mandate.